Newly Elected Prime Minister Abe Threatens Bank of Japan

Last week at the conclusion of their scheduled two day meeting that Bank of Japan announced that they would hold rates and add 10trillion yen to their existing asset purchase program. This action was expected by the markets.

At the same time the public statement following the banks decision surprised traders as the bank adopted a firm stance against newly elected Prime Minister Shinzo Abe saying that they would continue to hold inflation rates between 0-1% and that they would consider Shinzo Abe’s request to increase the inflation rate to over 2% at their next meeting, after the official installation of the Prime Minister on December 26^th, (this Wednesday). These comments were a carefully worded to show that the Bank of Japan was independent and not subject to political pressure. The USD/JPY liked the stance of the bank and the JPY was recovered a bit of strength to trade in the low 84.00 price range.

It did not take long for Prime Minister to be Abe, to fire back at the bank. This weekend, Abe drew a line in the sand. Abe threatened to revise the law governing the Bank of Japan if it refuses to introduce a 2 per cent inflation target at its January policy meeting. The comments by soon to be Prime Minister Abe, whose Liberal Democratic party won a landslide victory in this month’s general election, highlight his determination to push the BoJ to adopt a more aggressive monetary policy in an effort to end chronic deflation and boost economic growth. It marks the most explicit challenge yet from Mr. Abe to the independence the central bank has enjoyed since 1998 in setting monetary policy.

Economist say that by forcing the BoJ to print money to fund a huge planned programme of public works spending, Mr. Abe is putting at risk long-term faith in the solvency of a state that already has gross debt equivalent to more than 200 per cent of national gross domestic product.

Mr. Shirakawa, the BoJ governor, has warned that “monetizing” government debt could undermine confidence in Japan’s fiscal discipline, resulting in higher interest rates that would make it much harder to finance the deficit.

However, Abe has already made clear that Mr. Shirakawa will be replaced when his current term as governor ends in April and that his successor will be a candidate more willing to push aggressive easing. “We want to have someone who supports our thinking,” he said on Sunday.

Under the 1997 law governing the BoJ, which was implemented in April 1998, the central bank is tasked with preserving “price stability” but is able to decide itself how this should be defined and achieved. High quality global journalism requires investment. The current law requires that the BoJ’s autonomy in setting monetary policy “be respected”, although it also requires the central bank to maintain close contact with the government to ensure that its work is compatible with national economic policy.

The JPY continues to tumble this morning as markets do not like the idea of political pressure over independent central banks. The USD/JPY is trading at 84.36 while the EUR/JPY is exchanging at 111.30.